Autumn Statment

Initial thoughts on Autumn Statement and the ‘deficit crisis’

Posted On: Thu 05 Jan 2012 Posted In: News Our Publications Posted By: Andrew Rainford

Autumn statement and reaction

Andrew Rainford – Tax Manager

The press coverage of the recent Autumn Statement focused on the Euro crisis, and the perceived inaccuracy of the initial growth forecasts and public sector job cut estimates. And of course the failure of the Government to come anywhere close to its deficit reduction targets.

The ubiquitous beast that is ‘The Deficit’ is a largely misunderstood concept. Many incorrectly assume that the measurement of the national deficit is the amount of outstanding borrowings owed by the Government. This is possibly fuelled by an obsessive reporting of personal debt crises in the national media. In reality, it is perfectly normal and healthy for administrations to raise funds through borrowing, and most national governments do have a National Debt outstanding.

The deficit we have come to love to hate is actually more of a snapshot of the excess of spending over income in a given year. It can be thought of as a national Profit & Loss account, and gives a more short term understanding of how the country’s finances are currently shaping up.

Of course the two concepts are intrinsically linked – national; debt repayments form part of the annual spending figures, and so larger repayments contribute to a larger deficit (or smaller surplus). Additionally, countries with a smaller national debt can run a larger deficit more comfortably for longer than those with a larger debt figure, on account of the fact that the country with the larger debt will struggle to fill the deficit gap as it becomes harder and more expensive to borrow.

At first glance it may seem natural to assume that the Government is irresponsible to cover the deficit gap owing to the recession by additional borrowing; however this is an unrealistic argument. In times of recession, unemployment is higher, meaning that taxation revenue is lost (lower income). Additionally, social security benefits will increase by the same virtue, and the Government has to ensure these payments can be made to support the most vulnerable. This can only be met by increasing borrowing.

The graph shown illustrates the effect of the recession in 2008 on government income, and the subsequent widening of the deficit.

Clearly it is important to reduce the deficit; however this gap is caused by a drop in income, rather than excessive spending. It is questionable therefore whether large scale cut backs on spending will really achieve a gap reduction. In fact, as government income is in the main taxation, a series of cuts which stifle growth may even widen the gap.

Economic growth is the key to reducing the deficit, whether by investment or by well thought out policies. Increasing employment, encouraging enterprise and supporting businesses will increase tax revenues, leading to increased Government income. By contrast spending cuts, for example on large scale building projects, always have a knock on effect in that there is a secondary loss of corporation tax from the company that would have carried out the work, and also tertiary effect of further lost corporation tax and VAT on the materials from the suppliers.

It is moderately encouraging therefore to see the announcement of extra expenditure on infrastructure; although the actual amounts in terms of total current annual spend is a drop in the ocean. In contrast, it is disappointing to see that the 50% top tax rate is remaining, even though this measure has discouraged investment and innovation in the UK, and therefore possibly cost more in lost tax revenue than it has brought in.

Also welcomed was the record rise in the weekly amount of state pension; however this was tainted by the news that the rise in pensionable age to 67 will now come in 2026; 8 years earlier than previously announced.

Economic strategy is invariably driven and implemented by fiscal policy, and so it is perhaps surprising to note that from a tax point of view, the announcements were relatively low in number. The most important of them will be briefly presented and discussed in a subsequent report.